beyond rosenstein-rodan: the modern theory of coordination problems in development karla hoff abcde...
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Beyond Rosenstein-Rodan:Beyond Rosenstein-Rodan:
The Modern Theory of The Modern Theory of Coordination Problems in Coordination Problems in
DevelopmentDevelopment
Karla Hoff
ABCDE Conference, 4-18-00, Revised 9-16-00
A coordination failure can occur if:A coordination failure can occur if:
• Agents' behavior creates externalities
that
• raise the relative return to each agent of those behaviors
by an amount large enough that
• there are multiple equilibria, and some are better for everyone
Early 1970s: Early 1970s: Externalities are a “fable,” Externalities are a “fable,”
say Coase’s followerssay Coase’s followers
Coase (1974)British history suggests that market arrangements (once property rights are defined) can efficiently provide for lighthouses.
Cheung (1973)Contracts between beekeepers and orchard owners resolve the market failure of "unpaid" services
Old and modern views of externalities Old and modern views of externalities and public goodsand public goods
Old view:
“Atomistic”
New view:
“Ecological"
Externalities Beekeeper
Systematic, diffuse externalities• Search costs• Corruption• Spillovers in technology• Social and political interactions• Role model effects
Public goods Lighthouse
Price vector (if there are multiple equilibrium price vectors)Group reputationKnowledge
Are coordination failures important?Are coordination failures important?
• In theory?
• In empirical investigations?
• For policy?
Example 1. Training and innovationExample 1. Training and innovation
A central difference between advanced and less developed economies is the extent oftraining and innovation.
Can we explain a low level of training and innovationas a coordination failure?
Training and innovationTraining and innovation
Train Do not train
Worker’s decision treeWorker’s decision tree
InnovateDo not
innovate
Firm’s decision treeFirm’s decision tree
Suppose that there is perfect contracting between a firm and its employee.How can a “coordination failure” then occur?
Joint decisions are made by a single Joint decisions are made by a single worker and his employerworker and his employer
Period 1 Period 2Decisions over investment in innovation and training
output is produced
Separation with probability s
Source: Acemoglu 1997. Note: The pink node is a chance node, reflecting exogenous risk of separation.
Train and
innovateDo
neither
0Stay together
Separate
- C + B-C + [B • probability of a good
match]
Example 2. Rent-seekingExample 2. Rent-seeking
DC’s and LDCs differ in the extent to which economic activity is directed at
rent-seeking, rather than output enhancement.
Can we explain a high proportion of rent-seekers in the population as a
coordination failure?
Agent’s decision treeAgent’s decision tree
Cash crop producer
Subsistence producer
Rent seeker
510 if there are no rent-seekers
8if producers do notretreat to subsistence
Multiple equilibria may existMultiple equilibria may exist
$
0
payoff to cash-crop producer
High-income equilibrium
ratio of rent-seekers to cash crop producers
payoff to rent-seeker
Source: Murphy-Shleifer-Vishny 1993 Acemoglu 1994
10
8
5
Low-income equilibrium
Example 3. Social organizationExample 3. Social organization
Some neighborhoods are characterized by low civic
participation and crime, and also low maintenance of property.
Can we explain that as a coordination failure?
Household’s decision tree in residential Household’s decision tree in residential
communitycommunity
Buy home equity and expend effort in home and community improvement
Do not buy home equity and do not expend effort
3 assumptions: (1) Price appreciation depends on fraction (x) of households who are homeowners; (2) There are capital market imperfections; and (3) “Home improvement effort” can’t be contracted for.These assumptions imply that a homeowner’s payoff increases with income and with x.
Payoff to homeownership - cost of borrowing - cost of effort
Payoff to renting
Multiple equilibria may existMultiple equilibria may exist
Income, y
0 1
critical value of y at which homeownership becomes the preferred strategy
income of the richest xth percentile of households
x, fraction of homeowners
Blighted neighborhood
Neighborhood with high civic activism
Source: Hoff and Sen 1999
Unresolved QuestionUnresolved Question
How important are local interaction effects in explaining
divergent fortunes of countries and communities?
Ex. 4. Transition Economies and Ex. 4. Transition Economies and the Emergence of the Rule of Lawthe Emergence of the Rule of Law
There is a debate about two alternative strategies in the
transition process:
• regulation followed by privatization
versus
• privatization without prior regulation
Two ViewsTwo Views• “Privatization offers an enormous political benefit
for the creation of institutions supporting private property because it creates the very private owners who then begin lobbying the government...for institutions that support property rights.” Murphy-Shleifer-Vishny 1998
• “[The owner typically] doesn’t pay wages to the employees, doesn’t pay taxes, is not interested in the enterprise’s development, establishes subsidiaries in order to ‘pump out’ the assets while leaving only the legal shell of the company, etc.” Radygin 1999
Decision tree of agent with controlling interest in a Decision tree of agent with controlling interest in a firm,firm,
after privatizationafter privatization
State capture
Rule of law
VS VL
If VL > t > VS , the “efficient owner” is acreature of his environment
Note: The pink node is a chance node.
Tunnel value out
Maximize firm value
t
A “partial reform” trap is possibleA “partial reform” trap is possible
t
0 1
Critical value of t at which tunneling becomes the preferred strategyt*
Tunneling value for the richest xth percentile of owners
fraction of owners who tunnel
Rule of law
State capture
Source: Hoff 2000
Shift up to pink curve depicts the effect of an increase in the entrepreneurial ability of those with control rights, or greater confidence in the emergence of the rule of law
Summary of the ecological/social Summary of the ecological/social interactions perspectiveinteractions perspective
Agents’ decisions
Train/innovate or not
Rent-seek or produce
Own or rent
Tunnel or invest productively
the environment
search costs
returns to production
local civic participation
state capture or rule of law
•depend on,•shape & ultimately•may make traps of
Role for Policy ExperimentsRole for Policy Experiments
"The task of ... finding out which combination of activities should be coordinated is not unlike the problem of hundreds of people, scattered in a dense, foggy forest, trying to locate one another. ..even the market mechanism cannot solve it ...” Matsuyama 1995
There may be great scope for improvement through experimentation.